BILL ANALYSIS �
SENATE BANKING & FINANCIAL INSTITUTIONS COMMITTEE
Senator Noreen Evans, Chair
2013-2014 Regular Session
SB 1280 (Hueso) Hearing Date: April 9,
2014
As Introduced: February 21, 2014
Fiscal: Yes
Urgency: No
SUMMARY Would require the Department of Business Oversight
(DBO) to establish a licensure program for the provision of
unsecured consumer loans in amounts up to $1,000, as specified.
DESCRIPTION
1. Would require DBO to establish a licensure program for the
provision of unsecured consumer loans with principal amounts
up to $1,000, and would require the program to be designed
to ensure that the loan product allows licensees to receive
a reasonable rate of return on their investment, taking into
account the needs of the consumer.
EXISTING LAW
2. Provides for the California Finance Lenders Law (CFLL),
administered by DBO, which authorizes the licensure of finance
lenders, who may make secured and unsecured consumer and
commercial loans (Financial Code Sections 22000 et seq.). The
following are the key rules applied to consumer loans made
pursuant to the CFLL:
a. CFLL licensees who make consumer loans under $2,500 are
capped at interest rates which range from 12% to 30% per
year, depending on the unpaid balance of the loan (Sections
22303 and 22304). Administrative fees are capped at the
lesser of 5% of the principal amount of the loan or $50
(Section 22305).
b. In addition to the requirements in "a" above, CFLL
licensees who make consumer loans under $5,000 are prohibited
from imposing compound interest or charges (Section 22309);
are limited in the amount of delinquency fees they may impose
SB 1280 (Hueso), Page 2
(Section 22320.5; delinquency fees are capped at a maximum of
$10 on loans 10 days or more delinquent and $15 on loans 15
days or more delinquent); are required to prominently display
their schedule of charges to borrowers (Section 22325); are
prohibited from splitting loans with other licensees (Section
22327); are prohibited from requiring real property
collateral (Section 22330), and are limited to a maximum loan
term of 60 months plus 15 days (Section 22334).
c. In addition to the requirements in "a" and "b" above,
CFLL licensees who make consumer loans under $10,000 are
limited in their ability to conduct other business activities
on the premises where they make loans (Section 22154); must
require loan payments to be paid in equal, periodic
installments (Section 22307); and must meet certain standards
before they may sell various types of insurance to the
borrower (Sections 22313 and 22314).
d. Generally speaking, the terms of loans of $10,000 or
above are not restricted under the CFLL.
3. Until January 1, 2018, provides for the Pilot Program for
Increased Access to Responsible Small Dollar Loans within
the CFLL (Financial Code Section 22365 et seq.). Licensees
accepted into the pilot program are required to follow the
CFLL, but are allowed to charge slightly higher interest
rates, origination fees, and late fees to borrowers than is
allowed under the CFLL, as long as they adhere to specified
underwriting criteria, offer DBO-approved credit education
to their borrowers, report borrower payment history to at
least one major credit bureau, provide specified disclosures
to borrowers, and follow other rules intended to protect
consumers.
Loans made under the pilot program must have principal amounts
of between $300 and $2,500. Interest rates are capped at
36% on principal amounts up to $1,000 and at 32% on
principal amounts between $1,001 and $2,499. Origination
fees are capped at the lesser of 7% or $90 on the first loan
to a borrower; lesser of 6% or $75 on the second and
subsequent loans to a borrower. Late fees are capped at $14
for payments that are at least seven days late or at $20 for
payments that are at least fourteen days late (lenders must
choose between these two options). Actual insufficient
funds fees may also be charged. Minimum loan lengths are 90
days for loans with principal amounts less than $500, 120
SB 1280 (Hueso), Page 3
days for loans with principal amounts between $500 and
$1,499, and 180 days for loans between $1,500 and $2,500
COMMENTS
1. Purpose: This bill is sponsored by the California Hispanic
Chambers of Commerce to create a more robust, regulated
market for commercially viable, unsecured installment loans
under $1,000.
2. Background: Californians who lack credit scores or have
very thin credit files currently have very few affordable
options when they need to borrow money; credit cards and low
interest rate installment loans are commonly unavailable to
them. Californians with subprime credit scores also have
few options, and typically access payday lenders when their
incomes fail to match their spending needs.
The lack of choices available to borrowers who cannot qualify
for credit cards, bank, or credit union loans, and who
require credit with which to meet their expenses is borne
out by a comparison of the number of small dollar value
installment loans made each year in California with the
number of payday loans made each year. During 2012 (the
most recent year for which lending data are available for
all CFLL licensees), CFLL licensees made approximately
265,000 unsecured consumer loans with principal amounts
under $2,500. This compares with 12.3 million deferred
deposit transactions (payday loans), which were made by
licensed payday lenders during the same calendar year.
Although these numbers do not reflect all small dollar loans
made to Californians (an unknown, but likely significant
amount of lending is conducted into California by lenders
who operate online without California lending licenses),
these numbers are representative of the problem this bill
seeks to address - a relative lack of affordable
small-dollar installment loans in California.
The California Legislature has taken steps to help increase the
availability of responsible, small-dollar loans made to
Californians by California licensees (most recently through
enactment of SB 318, Hill et al., Chapter 467, Statutes of
2013). However, despite these recent steps, there is
consensus among for-profit businesses, not-for-profit
organizations, and the regulatory community that more should
SB 1280 (Hueso), Page 4
be done to encourage affordable, credit-building, small
dollar lending. This bill is an attempt to do just that,
using a novel approach not previously attempted.
3. Discussion: As noted immediately above, after years of
contentious debate within the Legislature over regulation of
small dollar loan products, SB 1280 represents a new
approach. While prior legislation proposed specific rate
and fee schedules and other specific lending rules, SB 1280
seeks to delegate the responsibility for determining the
specific terms of the new lending program to the department
that would administer this program. Although such an
approach is unprecedented within California's lending laws
(all of the state's existing and former lending and
regulatory programs were developed by the Legislature rather
than delegated to the Executive Branch), this bill's
approach has two considerable advantages over alternate
approaches that involve legislative drafting.
First, DBO has access to significant amounts of proprietary
lending data from its substantial licensee population.
Although private companies are loathe to publicly share
proprietary data about their costs, revenues, and profit
margins with the Legislature, they can and do share these
data on a confidential basis with their regulator. DBO's
lending licensee population numbers in the tens of thousands
and provides a rich source of valuable information. Thus,
DBO is in a much better position than the Legislature to
calculate the financial impact of a particular rate and fee
schedule on California lenders.
Second, DBO has access to similar types of proprietary
information from its fellow state regulators throughout the
country. Many other states are home to viable small-dollar
installment loan programs. While state regulators in these
other states are likely to be very hesitant to discuss
proprietary information regarding the performance of their
licensees with members of the California Legislature or
their staffs, these regulators are quite accustomed to
working cooperatively with their fellow state regulators.
DBO is in a much better position than the Legislature to
gain valuable insights from other state regulators whose
experience with lending programs in their states can inform
DBO's work on a new California loan product.
There is, of course, significant potential downside to
SB 1280 (Hueso), Page 5
delegating so much authority to DBO. DBO may develop a
lending program that a majority of California legislators
find unacceptable, but which will become law through the
operation of this bill. This Committee may wish to consider
requiring the lending program developed by DBO to be
returned to the Legislature for review, possible amendment,
and approval (or rejection), before it is allowed to become
law (see suggested amendments below).
4. Recent and Expected Actions By Federal Banking Regulators
and the Consumer Financial Protection Bureau: Although this
bill focuses on installment loan products, it should not be
debated without considering the significant changes that
have already begun and are likely to continue within the
payday advance and payday loan markets. Because installment
loan products are often viewed as "payday alternatives,"
recent and future changes to payday rules are relevant to
this bill.
In November 2013, the Federal Deposit Insurance Corporation
(FDIC) issued final guidance to depository institutions
titled, "Guidance on Supervisory Concerns and Expectations
Regarding Deposit Advance Products." In its release, the
FDIC stated that it expected banks to apply the principles
set forth in its guidance to any deposit advance product
offered by the banks it insures. It stated, "A deposit
advance product is a small-dollar, short-term loan or line
of credit that a bank makes available to a customer whose
deposit account reflects recurring direct deposits. The
customer obtains a loan, which is to be repaid from the
proceeds of the next direct deposit. These loans typically
have high fees, are repaid in a lump sum in advance of the
customer's other bills, and often are not subject to
fundamental and prudent banking practices through which a
bank can determine the customer's ability to repay the loan
and meet other necessary financial obligations."
FDIC's guidance requires banks to ensure that an extension of
credit in connection with a payday advance product,
including all associated fees and expenses, can be repaid by
a customer according to its terms, while allowing the
customer to continue to meet typical recurring and other
necessary expenses such as food, housing, transportation,
and healthcare, as well as other outstanding debt
obligations. Banks should ensure that customers can meet
these requirements, without needing to borrow repeatedly.
SB 1280 (Hueso), Page 6
Banks should take steps to prevent loan churning and
prolonged use of deposit advance products. Underwriting for
deposit advance products should occur before opening such
accounts and should be monitored on an ongoing basis.
According to the FDIC guidance, banks' underwriting of payday
advance products should ensure that the customer
relationship is of sufficient duration to provide the bank
with adequate information about the customer's recurring
deposits and expenses. Customer relationships at least six
months long are considered a bare minimum. Underwriting
should also review the customer's account for recurring
deposits and recurring withdrawals over a minimum six month
period and consider whether an installment loan from the
institution may be a better choice for a customer than a
deposit advance product. Banks should not offer more than
one payday advance per monthly statement cycle, and a
cooling off period of at least one monthly statement cycle
should be completed after a customer repays a payday
advance, before a new advance should be extended. Credit
line increases should not be automatic. Banks should
reevaluate their customers' eligibility for deposit advance
products at least once every six months.
According to American Banker magazine, every bank that was known
to have offered a payday advance product before the FDIC
guidance was released has now discontinued that product,
even banks not regulated directly by the FDIC. Although the
guidance was not intended to dry up banks' payday advance
market, it has had the effect of doing so, at least on a
short-term basis.
The federal Consumer Financial Protection Bureau (CFPB) has
signaled its intention to propose regulations later this
year regarding payday loan products offered by nondepository
institutions. Although CFPB has not yet signaled the
content of those regulations, nor speculated on when it is
likely to issue final regulations, many expect that the
CFPB's guidance will dramatically change the payday loan
market across the country.
5. Summary of Arguments in Support:
a. According to the author, "The problem that currently
exists is that Californians find it increasingly
difficult to access capital, especially for short-term
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and unsecured loan needs. The regulated marketplace
under the Consumers Finance Lender's Law allows for loans
under $2,500; however, very few lenders are utilizing
this law with its highly regulated provisions making such
loans unprofitable. Payday loans are an easy and
convenient way for consumers to acquire short-term cash
needs under $300 inclusive of fees, yet their loans have
hardly kept up with the pace of inflation since their
inception. Title loans are also an option for consumers
and small businesses; however, a clear title and a
vehicle is required before a loan can be secured. The
Legislature developed a short-term unsecured lending
product in the form of SB 1146 (Florez), and then a short
time later, repealed the law in favor of SB 318 (Hill).
Based on lenders we have spoken to who currently provide
short-term lending products, it would appear the good
created in terms of consumer protection limiting fees and
charges have gotten in the way of lender commercial
viability.
"The idea behind SB 1280 is to provide the regulator, in
this case the DBO, with the flexibility to develop a
product that takes into account a standard that will
allow a reasonably well run lender to make a reasonable
return on their investment while taking into account, the
risks associated with unsecured loans, as well as, the
interests of consumers."
b. This bill's sponsor, the California Hispanic
Chambers of Commerce (CHCC), writing on behalf of the 27
Hispanic Chambers in California, observes that access to
capital has been an important issue for CHCC for many
years. "We continue to support government programs,
either state or federal, that provide favorable terms to
small businesses...We are very familiar with such
short-term loan products as title loans, payday loans,
and pawn. The CHCC has never been opposed to such
products even though by traditional standards, the APR's
can be significant. As long as there is full disclosure
to the consumer and it is a regulated product, it is up
to the consumer to determine what product meets their
short-term cash needs.
"What we have observed in the last ten years is that payday
loans have not been increased to keep up with inflation,
and attempts by the Legislature to come up with new
SB 1280 (Hueso), Page 8
products have not been commercially viable. For example,
very few loans are made under $2,500 using the Consumer
Finance Lender Law due to heavy government
restrictions....Certainly the CHCC would like to have
these loans to our members be under the most favorable
terms; however, we are still a business organization. If
the government does not allow the marketplace to
determine rates, and no lender wants to lend under the
loans set forth by the Legislature, then it becomes an
illusory product. It is for this reason we strongly
support the concept stated in your bill, SB 1280.
Although [the] bill does not establish a total free
market-based loan system, at least it puts the discretion
to develop rates and fees in the hands of the regulator
to determine what is a viable product based on the data.
If lenders are not making a profit, then no company will
be making such loans."
Similar arguments in support were also submitted by the
South Bay Latino Chamber of Commerce and Los Angeles
Metropolitan Hispanic Chambers of Commerce.
c. The California Asian Pacific Chamber of Commerce
also supports SB 1280. "In today's economy, short-term
financing options are important for small businesses and
consumers, but difficult to come by. Today, there are
few options for loans and lines of credit for amounts
under $2,500. Existing options have onerous requirements
leaving borrowers with limited options, and many must
then turn to unlicensed, unregulated lenders offering
limited to no consumer protections. Small businesses
often need access to secure and well-regulated credit.
We believe SB 1280 helps strike a balance by creating an
alternative product that protects the rights of consumers
while allowing a reasonable rate of return for lenders."
Similar arguments in support were also submitted by the
Cambodian American Chamber of Commerce and South Asian
Business Alliance Network.
d. The Online Lending Alliance (OLA) is a national
trade association representing companies that make
short-term, consumer credit loans via the Internet. It
supports SB 1280 and views it as a creative way to bring
more licensed lenders in to the California market and
provide needed credit for those individuals who are
SB 1280 (Hueso), Page 9
already finding it difficult to borrow money. "Past
efforts to lower the threshold on CFLL loans have been
unable to balance the concerns of lenders and consumers.
Consumer groups generally oppose lowering the threshold
unless significant limits are placed on interest rates
and fees. But those limits unfortunately discourage
investors from entering that market. The reality is, the
limits are just too low to make up for the high cost of
money. SB 1280 creates a balanced solution." The
program that this bill would require DBO to develop
"would result in lenders coming into this state for
licensure. But by limiting the rate of return, SB 1280
also would keep fees and interest rates as low as
practical."
OLA also observes that "the idea of a statutory fair rate
of return is not unknown in California law. The
California Department of Insurance, which must approve
any change in any auto and homeowner policy, determines a
fair rate of return as part of the rate approval
process."
e. The California Financial Service Providers'
Association writes that California consumers seeking an
installment loan under $2,500 have few choices in the
legitimate marketplace. In 2012, fewer than one percent
of the total dollar amount of all consumer loans made
under the CFLL were for less than $2,500. Neither the
2010 pilot program (SB 1146) nor the 2013 pilot program
(SB 319) incentivized a significant number of lenders to
make small, unsecured installment loans. "The California
Statutes do not allow legitimate lenders to earn a
reasonable profit offering the loans consumers need.
This results in many consumers turning to unregulated and
unlicensed sources for credit, including the Internet
where loan offers abound with exorbitant costs, onerous
terms, and often-predatory collection practices. Many of
these sources are out of state and country and out of
reach of state regulators. Consumers are not protected."
6. Summary of Arguments in Opposition:
a. The Center for Responsible Lending (CRL) opposes the
bill on three grounds. First, the proponents of the bill
provide no details or parameters for the new loan license
and product they seek. Second, DBO should not be charged
SB 1280 (Hueso), Page 10
with developing products that ensure a degree of
profitability for any market participant. The
regulator's role should be to enforce the statutes
established by the Legislature, and not to ensure that
any particular product is profitable for any particular
type of lender. It should be the Legislature's job to
balance various stakeholder concerns to fashion any new
lending regime, as it has done with respect to all other
small dollar lending activity. Finally, now is not the
time to create a new small dollar loan product in
California. Just last year, the Legislature expanded
California's small dollar loan pilot (SB 318). CRL also
expects the CFPB to produce new rules governing payday
lending and possibly other small dollar loans later this
year. CRL urges the Legislature to wait to see the
results of both of these efforts before designing new
small dollar loan products.
Although CRL opposes the bill, it does urge this Committee
to add several specific requirements and safeguards to
the legislation. First, the bill should be amended to
require robust underwriting, which CRL believes should be
based on the consumer's verified income, as well as all
verified and reported debt obligations, other than loans
from family and friends, and other large regular expenses
such as rent. Second, the bill should include a 36%
annual percentage rate (APR) rate cap, inclusive of all
fees and interest. Third, any new loan program must have
protections against serial refinancing and fee generation
by the lender. Such protections should include a
provision for refunding the origination fee in order to
discourage churning of loans for fee generation. Fourth,
the bill should prohibit the sale of credit insurance
products in connection with the new loans the bill would
authorize. Fifth, the bill should prohibit the use of a
check or bank account as collateral. Sixth, there should
be limitations (unspecified) on the size and frequency of
late fees. Seventh, the bill should ensure that larger
loans have longer minimum loan terms. Finally, loans
authorized by the bill should be amortized with
substantially equal payments.
b. The California Reinvestment Coalition (CRC) opposes
the bill for similar reasons as those expressed by CRL.
The current version of the bill provides no clear
criteria about what types of loans would be authorized
SB 1280 (Hueso), Page 11
under the new loan license. CRC is concerned that the
bill is intended to pave the way for larger payday loans
or high cost installment loan products. "We oppose any
expansion of the payday loan industry and other loan
products carrying triple-digit interest rates and fee
structures, balloon payment requirements, and lenders'
direct access to consumers' bank accounts. We also
oppose any loan products that do not implement strong
underwriting standards to determine the consumers'
ability to repay the loan while maintaining the means to
cover their other debts and expenses."
Like CRL, CRC urges the Legislature to allow the existing
pilot program under the CFLL to run its course, analyze
the performance data resulting from the pilot, and base
any recommendations and changes in the small dollar loan
regulatory space on existing data and consumers' needs,
"not on the industry's desire to expand their suite of
high cost products."
Finally, CRC notes the upcoming rulemaking expected from
the CFPB. "The California Legislature should hold off on
designing and enabling the introduction of new small
dollar loan products until the CFPB's new rules are
enacted. To proceed with product development and
authorization now would be premature."
c. Numerous other consumer advocacy organizations,
including the Law Foundation of Silicon Valley, Housing
and Economic Rights Advocates, Opportunity Fund, Mission
San Francisco Community Financial Center, Montebello
Housing Development Corporation, and others also oppose
the bill for reasons cited by CRL and CRC.
7. Amendments:
a. The following amendments are suggested, in order to
provide more clarity to DBO and comfort to interested
parties regarding the topics DBO should consider when
developing the new licensure program:
Page 2, strike lines 9 through 14 and insert:
(b) In developing this program, the department shall
consider all of the following, at a minimum:
SB 1280 (Hueso), Page 12
(1) The minimum and maximum principal amount of loans that
may be extended by lenders approved as licensees under
the program;
(2) The minimum and maximum length of program loans;
(3) The interest rates and fees that lenders should be
allowed to charge, and the extent to which these rates
and fees:
i. Are fair and reasonable to
borrowers given state and federal consumer
protection guidance and the rates and fees
associated with other lending alternatives for
which these borrowers may be eligible;
ii. Are fair and reasonable to lenders
given lenders' cost of funds, the risk profiles
of these loans, and the returns on investment
common to licensed nondepository lenders that
offer unsecured installment loan products in
states other than California.
(4) Whether program loans should be underwritten, and, if
so, the underwriting criteria that should be applied;
(5) Whether interest rates and fees should vary from
borrower to borrower, depending on the risk profile of
each borrower;
(6) Whether borrower repayment history should be reported
to a consumer reporting agency that compiles and
maintains files on consumers on a nationwide basis;
(7) Whether licensees should be required to offer credit
education approved by the department to borrowers who
seek out program loans, and whether lenders should be
able to offer rate and fee discounts to borrowers who
complete such education;
(8) What disclosures should be provided to borrowers at
the time a loan application is submitted;
(9) Whether lenders that offer program loans should be
able to offer other loans or insurance products
concurrent with a program loan;
(10) Whether, and under what circumstances, past-due
loans may be referred to independent third parties for
collection;
(11) Whether, and under what circumstances, lenders that
offer program loans may use unlicensed persons to aid in
identifying borrowers who may be eligible for program
loans;
(12) The frequency with which licensees should be
SB 1280 (Hueso), Page 13
examined, and the manner in which the costs of these
examinations should be allocated;
(13) The nature of reporting that will be required of
program licensees and of DBO regarding lender and
borrower performance under the program;
(14) Whether the lending program should replace existing
CFLL rules for installment loans of similar amounts or be
offered as an alternative to the existing CFLL;
(15) How the success of the lending program will be
measured.
b. If this Committee wishes to require DBO to submit
its new loan program to the Legislature for review,
possible amendment, and approval (or rejection), the bill
could be amended as follows:
(a) The Department of Business Oversight shall establish
develop detailed recommendations for submission to the
Legislature regarding the creation of a licensure program
for the provision of unsecured consumer loans in
accordance with this article.
[Insert the language summarized in 6a, immediately above]
(c) The department shall include its detailed
recommendations in a written proposal, which shall be
submitted to the Legislature on or before January 1,
2016.
c. In the alternative, if this Committee prefers to
defer more completely to DBO, the following amendments
are suggested:
(a) The Department of Business Oversight shall establish,
through regulation, a licensure program for the provision
of unsecured consumer loans in accordance with this
article.
[Insert the language summarized in 6a, above]
8. Prior and Related Legislation:
a. SB 1146 (Florez), Chapter 640, Statutes of 2010:
Authorized the Pilot Program for Affordable
Credit-Building Opportunities to help encourage
socially-responsible, for-profit lenders to offer
SB 1280 (Hueso), Page 14
installment loans in amounts under $2,500.
b. SB 318 (Hill), Chapter 467, Statutes of 2013:
Modified the provisions of SB 1146 to help attract more
lenders to the pilot program and help increase the number
of loans that existing lenders could afford to make.
Sunsets on January 1, 2018.
c. SB 896 (Correa), 2013-14 Legislative Session: Would
authorize a non-profit organization that meets certain
criteria to apply to DBO for an exemption from the CFLL
and would require a non-profit organization granted an
exemption by DBO to comply with specified requirements
related to the loans it facilitates. Would further
provide that non-profit organizations which partner with
exempt non-profits are not subject to the CFLL, if they
meet specified criteria and comply with specified
requirements. Pending in the Senate Banking and
Financial Institutions Committee.
LIST OF REGISTERED SUPPORT/OPPOSITION
Support
California Hispanic Chambers of Commerce (sponsor)
California Asian Pacific Chamber of Commerce
California Financial Service Providers' Association
California State Council of Laborers
Cambodian American Chamber of Commerce
Greater Riverside Hispanic Chamber of Commerce
Los Angeles Metropolitan Hispanic Chambers of Commerce
Online Lending Alliance
Orange County Hispanic Chamber of Commerce
Plaza de la Raza
South Asian Business Alliance Network
South Bay Latino Chamber of Commerce
Teamsters Joint Council 42
Valley Industry and Commerce Association
Opposition
Asian Law Alliance
California Reinvestment Coalition
Center for Responsible Lending
Housing and Economic Rights Advocates
SB 1280 (Hueso), Page 15
Law Foundation of Silicon Valley
Mission SF Community Financial Center
Montebello Housing Development Corporation
Opportunity Fund
St. Joseph's Family Center
Sunnyvale Community Services
United Way Silicon Valley
West Valley Community Services
Working Partnerships USA
Consultant: Eileen Newhall (916) 651-4102